Tax Court Further Loosens the Strings on Formula Gifts

The Internal Revenue Code provides for a tax on gifts. However, annual exclusion gifts of $13,000 per recipient and gifts that do not exhaust a donor’s available unified credit will not generate a current gift tax. Thus, donors often seek to make gifts that come within, but that do not exceed, the above exemptions and credits.

This can be difficult if the gift is of property and not cash, since the precise value of the gift may not be known. Therefore, donors will want to include terms to their gift that if the value, as determined by the IRS, exceeds what was expected, the amount gifted will be scaled back to come within the exemption or credit amounts. However, at least since the case of Commissioner v. Procter, 142 F.2d 824, 827-828 [32 AFTR 750] (4th Cir. 1944), donors have run a significant risk that the IRS and courts would not respect such arrangements.

In recent years, several favorable taxpayer cases have upheld somewhat complex arrangements that seek to accomplish such adjustments, such as Estate of Petter v. Commissioner, T.C. Memo. 2009-280 [TC Memo 2009-280], aff'd, 653 F.3d 1012 [108 AFTR 2d 2011-5593] (9th Cir. 2011) and Estate of Christiansen v. Commissioner, 130 , T.C. 1 (2008). The taxpayers in the favorable cases have melded the gift-giving with either gifts to charities or disclaimers. These elements were added in large part because established gift tax law for charitable gifts and disclaimers allows for the use of “formulas” to define the amount of a gift, and also to bring in third parties that will purportedly enforce the clause or that have favorable public policy elements (such as enhancing charitable gifting).

The Tax Court has now ruled in favor of a donor that used a formula gift, but did not include any charitable gifts or disclaimers. Such an arrangement is of course much easier to implement in a usual gift-giving scenario, and thus substantially lowers the bar for taxpayers who want to use formula gifts to avoid inadvertent gifts.

The case largely turns on the formula which defines the gift as a given dollar amount of property. Thus, while an initial property transfer based on the taxpayer’s estimation of value will be undertaken, the amount of property transferred will be readjusted if the subsequent appraisal, the IRS or the courts determine a different value. This is to be distinguished from a gift of a fixed amount of property, that will later involve additional transfers of property back or forth based on IRS valuations. Is there really a difference between the two? It is hard to say. What is clear is how to draw a qualifying transfer that the Tax Court likes: express the amount of property transferred as a formula, as a stated dollar value to be transferred. The only variable should be the finally determined value for the property that is to be transferred. The court found the following language from Petter to be central to this issue:

Under the terms of the transfer documents, the foundations were always entitled to receive a predefined number of units, which the documents essentially expressed as a mathematical formula. This formula had one unknown: the value of a LLC unit at the time the transfer documents were executed. But though unknown, that value was a constant, which means that both before and after the IRS audit, the foundations were entitled to receive the same number of units. Absent the audit, the foundations may never have received all the units they were entitled to, but that does not mean that part of the Taxpayer's transfer was dependent upon an IRS audit. Rather, the audit merely ensured the foundations would receive those units they were always entitled to receive.

Some additional important points and observations from this case include:

a. The donees were family members of the donor. Thus, the court did not believe the family relationship alone would void the effective operation of the formula clause although this was not expressly discussed.

b. While Petter included language regarding the policy of encouraging gifts to charitable organizations, that factor was not determinative to the acceptance of a formula clause. Here, there was no charity involved and the court expressly noted that this element of Petter was not a requirement to an effective formula gift.

c. In drafting a formula and transfer arrangement, it should be clear that the donor’s intent was to transfer only a certain fixed dollar amount of property, and not to transfer a fixed amount of property that would be later readjusted.

d. The properties transferred here were interests in a partnership. The IRS argued that since the capital accounts were adjusted to provide for the initial number of units transferred, that fixed the amount of the gift by state law and a later revaluation could not undo the gift. The court rejected this, both on legal grounds, and on the factual that it was not clear that the capital accounts had been adjusted for the gifts based on the initial transfer amount. What happens in a case when the capital accounts are formally adjusted based on the initially determined transfer amount so that the factual argument is not available to a taxpayer? Based on the language of the court, even in that situation it would appear that this would not create a basis for a taxable gift because of the legal argument that the capital accounts do not control.

Does this case mean that formula gifts can be undertaken now without charitable or disclaimer elements? Perhaps yes, but more conservative planners may still want to include the charitable or disclaimer elements for more certainty, at least until additional favorable precedent arises.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.

- hide

Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.